Bulls Stir to Verizon Calls Following Vodafone Deal

By ending the 14-year joint venture with Vodafone of Britain, Verizon Communications Inc. keeps all of the earnings in Verizon Wireless and gets more leeway to upgrade its mobile network. Photographer: Ron Antonelli/Bloomberg

Feb. 28 (Bloomberg) -- Options traders are turning bullish
on Verizon Communications Inc., convinced it can wring extra
profit from its wireless venture and that the stock will rebound
after Vodafone Group Plc shareholders are done selling.

The price of bullish calls has climbed to the highest level
in seven years compared with corresponding puts, signaling
speculation the underlying stock will rise, data compiled by
Bloomberg show. Shares of the New York-based phone company have
fallen 12 percent since reaching a 13-year high in April in
anticipation of the Vodafone transaction.

Verizon closed its $130 billion deal last week to gain full
control of its wireless unit with the issuance of 1.27 billion
shares to Vodafone’s owners, and some traders probably sold
them, according to Jonathan Schildkraut, an analyst at Evercore
Partners Inc. in New York. The decline gives investors the
chance to purchase Verizon equity at a discount, he said.

“The deal adds a lot of long-term value to Verizon
shares,” Schildkraut said by phone on Feb. 24. “You’ve got
technical pressure, and you don’t know if that’s going to last a
week or four. But the fundamental story actually gets better.”

By ending the 14-year joint venture with Vodafone of
Britain, the U.S. company keeps all of the earnings in Verizon
Wireless and gets more leeway to upgrade its mobile network. The
acquisition is Chief Executive Officer Lowell McAdam’s bet that
the wireless market still has room for expansion even as growth
slows in smartphone sales.

While most people already have smartphones and data plans,
McAdam has said the industry is on the cusp of a new surge in
demand for mobile connections as customers seek to link their
cars and home-monitoring systems to the Internet.

‘Risk-Free Bet’

Revenue will climb 4 percent this year, compared with 4.1
percent growth last year, Verizon said Feb. 24 in a statement,
with profit margins forecast to expand in both the wireless and
landline businesses.

The deal “is an execution, risk-free bet that wireless is
the future,” Roger Entner, an analyst at Dedham, Massachusetts-based Recon Analytics LLC, said in a Feb. 26 phone interview.
“If Verizon believes it can execute as well as it has in the
past, it has basically integrated all the profits in Verizon
Wireless into the company. That’s a massive positive.”

The stock trades at 13.6 times projected earnings, less
than the 15.7 ratio for companies in the Standard & Poor’s 500,
according to data compiled by Bloomberg. Analysts predict
Verizon could climb to $54.15 in the next 12 months. The stock
jumped 2.5 percent yesterday to $47.50.

Increased Shares

Verizon fell to $45.98 on Feb. 18, the lowest level since
September when the Vodafone deal was first announced. The shares
are down 7.1 percent from an October peak. The deal has
increased the stock outstanding by 45 percent to 4.1 billion.

“What kept pressure on the stock is all these additional
Verizon shares being issued to Vodafone shareholders,” David
Heger, an analyst in St. Louis with Edward Jones & Co., said in
a Feb. 27 phone interview. “There has been a thought that
people would dump all of the shares once they got them.”

Puts with an exercise price 10 percent below Verizon’s
stock cost 1.41 points more than calls betting on a 10 percent
increase, according to three-month data compiled by Bloomberg.
The price relationship known as skew fell to 0.67 on Feb. 26,
the lowest since March 2006.

Ray McConville, a spokesman for Verizon, declined to
comment on the company’s options trading.

Price War

Verizon is seeking to improve profit margins amid a mobile-phone industry price war. T-Mobile US Inc. has offered to buy
out rivals’ customers from their contracts and introduced
cheaper international calling plans, and AT&T Inc. and Sprint
Corp. have mimicked its moves. Instead of cutting the cost of
its wireless plans, Verizon has added features like bigger data
allotments and free network storage.

Verizon’s LTE network speeds have fallen behind AT&T and T-Mobile’s in recent tests, while the company’s plans and costs
are more expensive, according to Joseph Mastrogiovanni, an
analyst at Credit Suisse Group AG who rates the shares neutral.
Mastrogiovanni cut his 12-month target price on Verizon to $52
from $53 this week after Verizon’s revenue forecast was lower
than the firm expected.

‘Competitive Landscape’

Verizon “noted that recent changes in the competitive
landscape do not appear to be fundamentally different than
competition it has seen in the past,” he wrote Feb. 24.

The Chicago Board Options Exchange Volatility Index, the
measure of expected volatility on the S&P 500 also known as the
VIX, fell 0.3 percent to 14 at 4 p.m. in New York. Europe’s
VStoxx Index dropped 2.1 percent to 16.77.

Implied volatility, used to gauge the cost of options, for
three-month contracts with an exercise price 10 percent below
Verizon’s shares has climbed 6.3 percent to 21.92 this year,
data compiled by Bloomberg show. That compares with a 21 percent
gain to 20.51 for calls 10 percent above.

Eight of the 10 most-owned Verizon options were bullish.
March $47 calls had the highest open interest, followed by calls
expiring in March with a strike price of $49, 3.2 percent higher
than yesterday’s closing price.

“Skew typically goes lower as stocks grind lower and
protection becomes less in demand,” Kurt Ayling, a technology,
media and telecom desk analyst at Susquehanna Financial Group
LLLP, said in an interview Feb. 27. “In this case, with such a
large overhang essentially being removed in the near term, the
shift in skew and the recent influx of bullish activity that
we’ve seen suggests investors believe the selloff may be
overdone and shares appear to have bottomed out.”